What is a Pareto Efficiency or Pareto Optimality?

Pareto Efficiency or Pareto Optimality pertains to the highest efficiency level resulting from an optimal allocation where any change to this allocation would make someone or something worse off. A situation is Pareto Efficient when there is no better alternative allocation: no individual or preference criterion can be better off without making at least one individual or preference criterion worse off or without any loss thereof.

What are the origins of the Pareto Efficiency Concept?

Pareto Efficiency’s concept originates from Vilfredo Pareto (1848–1923), the Italian civil engineer and economist who is better known for the Pareto Principle, also known as the 80/20 rule or Pareto Law. The Pareto Principle is used across industries with Pareto Charts (diagrams) or Pareto Analysis (data tables).

Where is Pareto Efficiency used?

Although Pareto Efficiency’s concept is prevalent in Economics with the Pareto improvements in Welfare, it is used in various domains such as Engineering.

Why is a Pareto Efficient approach interesting?

In a multi-objective optimization context, a Pareto efficient approach allows making tradeoffs within a set of choices that overall yield the same optimal “efficiency” or “utility” rather than considering the full range of every possibility. For a given situation, the set of choices that maximize the “efficiency” or “utility” is called the Pareto frontier or Pareto set, or Pareto front.

What is a Pareto Efficient Economy?

An economy is Pareto Efficient when its goods and resources are allocated to the optimal efficiency level, at which point no change can be made without making someone worse off.

In a neoclassical economy, a Pareto efficient outcome is an action that harms no one and helps at least one person.

Economists Kenneth Arrow and Gerard Debreu demonstrated, theoretically, that under the assumption of perfect competition and where all goods and services are tradeable in competitive markets with zero transaction costs, an economy will tend toward Pareto Efficiency.

How do I know if a situation is Pareto efficient?

• A situation is Pareto optimal or Pareto efficient if no progress is possible without having some agent being worse off
• A situation is called Pareto dominated if a Pareto improvement exists: one or more agents will gain from the new allocation, but no agents will lose.

Conclusion and Suggestions

For more content like this about time and resource allocation, please read our blog ParetoAnalysis.Tools/Blog.